A Snapshot Of Charles Schwab’s Business [Part I]

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Charles Schwab
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    Quick Take
  • Charles Schwab operates in two reportable segments: Investor Services and Institutional Services.
  • The Investor Services segment provides banking and retail brokerage services to individual investors, and the Institutional Services division serves independent investment advisors by providing them custodial, trading and support services.
  • Both the segments primarily earn money in the form of (1) asset management and administration fees, (2) net interest revenue, and (3) trading revenue.
  • We believe the company’s growth primarily depends on three main drivers: (1) asset levels (2) interest rate environment, and (3) trading volumes.

Charles Schwab (NYSE:SCHW) is a financial services company that provides its customers securities brokerage, banking, money management and financial advisory services. The company recently celebrated its 40th anniversary boasting of over $2 trillion in client assets as of April month-end. [1] The company operates through two reportable segments — Investor Services and Institutional Services.

The Investor Services segment provides banking and retail brokerage services to individual investors while the Institutional Services division serves independent investment advisors by providing them custodial, trading and support services. Of the two segments, the Investor Services is the larger and more visible segment. It accounts for almost 66% of the company’s total net revenue in 2012 and around 57% of its total client assets. On the other hand, the Institutional Services segment accounted for around 32% of the company’s 2012 net revenue and 43% of total client assets.

Investor Services Institutional Services Total
Client Assets ($ B) 1,190.2 894.7 2,084.9
Net New Assets ($ B) 27.5 15.9 43.4
2012 Total net revenues ($ M) 3,228 1,583 4,883

Both of the segments primarily earn money in the form of (1) asset management and administration fees, (2) net interest revenue, and (3) trading revenue.

Here is a brief description of these segments:

Asset management and administration fees: Schwab provides its clients access to several proprietary and third-party mutual funds and fee-based advisory solutions. The proprietary funds are provided from two fund families called Schwab Funds and Laudus Funds while third-party mutual funds are provided through Mutual Fund Marketplace. For managing the money in these investment vehicles, the company charges its clients a fee, which is a small percentage of the total assets under management in these vehicles. The company earns an asset based fee for providing record keeping and shareholder services to third-party funds.

Net interest income: Much like any other bank, the company invests client deposits at a higher rate than it pays for those funds earning the net interest spread.

Trading revenue: Schwab charges its customers a flat fee of $8.95 per trade for buying and selling stocks online. The pricing increases if value added services are used and vary for other investment products such as options and mutual funds. You can review the company’s trading commission rates here.

What Are The Major Growth Drivers For The Firm?

The company’s growth primarily depends on three main drivers: (1) asset levels (2) interest rate environment, and (3) trading volumes.

Asset Levels: The asset management and administration fees and net interest revenue are asset based revenues. This means that the income from these sources increases as the asset levels in the respective categories increase. Specifically, net interest revenue depends on the level of interest earning assets on the company’s balance sheet while asset management and administration fees depends on the assets under management in mutual funds and fee-based advisory solutions at Schwab.

Interest Rate Environment: Net interest revenue depends on the net interest spread that the company is able to generate. This spread usually varies with the prevailing interest rates and are currently at historic lows due to the low interest rate environment created by the Fed’s dovish macroeconomic policy.

Trading Volume: Trading commission revenue is volumes based – it increase with an increase in the number of trades on Schwab’s platform.

What’s Impacting These Growth Drivers?

The macroeconomic environment has been tough for some time now, and trading volumes are low due to investor skittishness while net interest spreads are suppressed due to the Fed’s quantitative easing program, which is keeping interest rates at historically low levels. However, Schwab has continued to attract client assets on a net basis in recent years. This not only offsets the negative impacts of low trading volumes and interest rates, but also sets the company up for future growth once interest rates and trading volumes recover.

We will look at each of these drivers in detail in our future articles.

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Notes:
  1. Schwab Reports Monthly Activity Highlights, Charles Schwab, May 14, 2013 []
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